Cormac:
This I understand...this is a basic understanding of the difference between a long and a short...a long only has a potential loss of the value of the position when bought...whereas a short has unlimited potential (in theory).
OZ
Brec. and I had already agreed to this point from the very beginning. I do not know why Atto is bringing up this more obvious part of the equation
That is not *at all* what I was saying. I was pointing out that even though both accounts in my example lost 100% of account equity, in the long example the risk also gradually decreased until it reached 0, while the risk in the short example increased. Though, clearly I chose the wrong example to simplify things :))
Let's use your example:
Person A
SHORT EXAMPLE
1>A margin account begins with $20,000
2>You short $10,000 and it goes against you $2000.
3>Account equity is now $18,000
4>Value of stock is $12,000
5>Short Position Value $8,000
6>%exposure is now 8000/18000 or 44%
Person B
LONG EXAMPLE
1>A margin account begins with $20,000
2>You Buy $10,000 long and it goes against you $2000.
3>Account equity is now $18,000
4>Value of stock is $8000
5>Long Position Value $8,000
6>%exposure is now 8000/18000 or 44%
Brec, as I understand it, was simply saying that even though both the short position and the long position started as 50% of account equity, the current value of stock is now 44% of account equity in the long example, and 66% of account equity in the short example.
The risk of losing, for example, 20% of your current account equity is equal to the probability that the stock in which you have a position can drop/go up enough to cause that 20% loss. If your position is equal to 100% of your account equity, then the stock has to only drop/go up by 20% of it's current price. If it's equal to 50% then the stock has to drop/go up by 40%. If we are talking about the same stock, then clearly the latter is less likely.
If we are talking about two different issues, then this only changes if you have some information that would cause you to believe that one of the stocks is less likely to drop/go up than the other. The only such information in your example might be the fact that one stock has already lost 20% of it's value, and the other gained 20% (as I said in my previous post). But if this isn't significant, or you don't know what difference this might make, then you have to assume that another drop of 20% (of the share's current price) in your long example is just as likely as a 20% gain in your short example (this is also making the assumption that a 20% drop in the price of any random issue is just as likely as a 20% increase in that same issue, but then, if it isn't, it also wouldn't have been when you originally bought/sold short the stock, so this doesn't change the increase/decrease in risk).
So, in the short example, the value of your stock is now $12,000. Another 20% increase would make it worth $14,400, your account equity would now be $15,600, which means you just lost 13% of the $18,000 in account equity you had before the second increase in price.
In your long example the value of your stock is now $8,000. Another 20% drop would make it worth $6,400, your account equity would be now $16,400, which means you just lost 9% of the $18,000 in account equity you had before the second decrease in price.
Earlier OZ wrote:
SIMPLY STATED: If I hold long 100 shares of a 50 dollar stock and it goes down 10 points it depletes my account capital by (10 x 100) or $1000. And deletes my buying power by $2000. in a margin account. If I am short the 100 shares and the stock goes up 10 points it depletes my account by $1000. and my buying power by $2000.. This 1:1 relationship continues as a 1:1 relationship wether it is a 10, 20, 30, 40 or 50 point gain or loss. All elements of risk and as you said "capital consumption" ARE identical, that is up to the point the long holders stock drops 50 and he cannot lose anymore and the short holder position goes up 50 and his problem can continue to infinity.
Ok, so let's go back to the example at the top of this post, and let's say that the price per share when the stock was originally bought/sold short was $100. After the first increase/decrease the price would be $120 in the short example and $80 in the long example. You are saying that another 20 point loss in the long example and a 20 point gain in the short example would change account equity by the same dollar amount.
That is true, but this would only mean that risk for both positions remained the same if equal point increases/decreases were equally likely regardless of the current price per share. In other words, if a stock with a price of $1,000 per share was just as likely to increase/decrease by 50 points as a $50 stock would be. This is clearly not true, and even though the difference in price per share is smaller ($40) it still makes a second 20 point loss in your long example less likely than a second 20 point gain in your short example (again, assuming neither previous price action nor the choice of either going short or long makes any difference).
atto |
